Economic Downturn Emboldens Shareholder Activists

By Tomoeh Murakami Tse
Washington Post Staff Writer
Tuesday, February 19, 2008

NEW YORK -- Investor groups angered by plunging stock prices are vowing to hold executives and corporate board members accountable at annual shareholder meetings this spring, turning up the pressure on U.S. companies already reeling from the credit crunch.

Activist investors are targeting a variety of financial services companies, including Citigroup, Merrill Lynch and Washington Mutual. Shareholder proposals demand that major banks better disclose mortgage-related risks, that Wall Street investment firms provide more transparency on their executive succession plans, and that credit-rating agencies address potential conflicts of interest that arise from what critics say is an all-too-cozy relationship with companies that pay them to rate securities.

One activist group, CtW Investment, has asked board members at major financial institutions to spell out exactly what they did to address the subprime mortgage-related losses, which have wiped out hundreds of billions of dollars in shareholder value and threaten to pull the economy into a recession. The group is promising a vigorous campaign urging investors to withhold votes from directors if they fail to explain themselves.

Meanwhile, a network of shareholder groups, furious over multimillion-dollar payouts to financial executives during some of the worst corporate performance ever, has upped its efforts to rein in executive compensation.

"We have a singular focus on the residential homebuilding crisis, the credit crisis," said Jennifer O'Dell, assistant director of corporate affairs at the District-based Laborers' International Union of North America, which has filed shareholder proposals at 28 companies it sees playing a role in the turmoil. "Shareholders are so angry, the public is so angry. . . . The worlds have aligned. The crisis is so severe that we do have more leverage now," she said.

The credit crisis stems from the housing market decline and ensuing losses in securities related to subprime mortgages. During the five-year housing boom that peaked in mid-2005, mortgage lenders approved billions of dollars of loans to home buyers with risky credit. Those mortgages were bought by Wall Street investment banks, which pooled the loans before slicing them into complex securities. These were given ultra-safe, AAA ratings by credit-rating agencies and sold to investors around the world. As homebuyers started defaulting on their mortgage payments and investors grew increasingly risk-averse, the value of the securities plunged.

Management experts likened the current environment of shareholder activism to the period following the Enron scandal, which motivated shareholders to challenge corporate boards. But this time, the losses are larger and more widespread, with toxic subprime mortgages showing up in the investment portfolios of Wall Street banks, large institutional money managers, pension plans and even small towns overseas.

Shareholders have also been emboldened by their success over recent years in advocating changes in corporate governance, notably rules calling for directors to be elected by a majority of stockholders. That change has gained wide acceptance, with many companies shifting to majority voting from an earlier system in which shareholders could abstain but not vote against directors.

Charles M. Elson, director of the Weinberg Center for Corporate Governance at University of Delaware, said the shareholder resolutions -- many of which are filed by union pension funds with relatively small stakes in each company -- are unlikely on their own to prompt much change. But, he and others said, the resolutions serve as a measure of shareholder unrest, and high investor support for them could create an opening for hedge funds and shareholders with larger stakes to mount a takeover campaign for board seats.

"The more dissatisfied the investors appear, the more likely someone opportunistic will come in and challenge management and effect change," Elson said.

The responses from companies vary. Some are actively meeting with shareholders, who in some instances have withdrawn their proposals once the companies accepted changes. For example, the Laborers' union said two affiliates withdrew a proposal seeking better disclosure of mortgage-related risks at Ryland Group after the home builder, which has a mortgage-lending unit, agreed to regularly report what types of home loans it makes and who purchases the mortgages in the secondary market.

A Ryland spokeswoman, citing fair disclosure rules, said the company could not comment on the specifics of the proposal but expects to address the group's concerns in its annual report, to be filed later this month. Lehman Brothers, Bear Stearns, Washington Mutual and Beazer Homes, which received similar proposals, have sought approval of the Securities and Exchange Commission to keep them from coming to votes. The SEC granted the requests of Bear Stearns, Lehman and Washington Mutual but denied Beazer's. Bear Stearns and Lehman declined to comment. Washington Mutual and Beazer did not return phone calls. Beazer, however, announced this month it would stop writing mortgages.

Credit agencies, which rated billions of dollars' worth of mortgage-backed securities as safe investments, have also come under shareholder scrutiny. Moody's and the parent company of Standard & Poor's received proposals demanding, among other things, that boards of directors be directly involved in managing potential conflicts of interest with clients.

The companies, which last week won approvals from the SEC to keep the matter off the ballots, declined to comment on the proposals.

But earlier this month, Standard & Poor's announced new measures to "enhance independence," including rotating lead analysts and hiring an outside firm to conduct regular reviews. Moody's also proposed changes this month to its rating process and is asking for feedback from customers.

Merrill Lynch and Citigroup, which together have written down $46 billion in mortgage-related securities by restating their value on company books, are also targets of shareholder proposals.

The AFL-CIO has filed proposals at both, asking that any employment agreements with executives be limited to three years. The proposals also seek the exclusion of "evergreen" clauses that provide for automatic renewal of employment agreements without shareholder approval, bans on accelerated vesting of stock options and on "excise tax gross-ups" under which companies essentially pay for executives' taxes on certain pay. The AFL-CIO said its proposals came partly in response to the multimillion-dollar pay packages awarded to the chief executives of the two companies, who both left late last year.

Merrill declined to comment on the proposal. A Citigroup spokeswoman said concerns raised in the proposal are addressed in its senior executive compensation guidelines and current practices. Merrill also faced a proposal that sought expanded disclosure of succession plans but got SEC approval to keep the measure from coming to a vote.

Merrill and Citigroup, along with four other firms, have also been the focus of CtW Investment, which is calling for directors on committees responsible for risk oversight to describe what they did to protect shareholders from mortgage-related losses.

"These are institutions that are at the epicenter of the meltdown. Their shareholders have taken huge losses, and they helped destabilize the market," said Michael Garland, director of value strategies at CtW Investment, which works with pension funds on corporate governance. "We want to be comfortable that the board is comprised of directors who are protecting the interest of shareholders an acting independently of management."

Citigroup said its directors on the audit committee acted responsibly and that there is "no basis for an election challenge." Merrill also said its board acted appropriately.

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